AMD Falls 13% Even as Price Targets, Estimates Rise

By Tiernan Ray

Shares of Advanced Micro Devices (AMD) today closed down 61 cents, or 13%, at $4.03, after the company yesterday reported better-than-expected Q2 results and a Q3 revenue view that also topped consensus expectations.

What spooked the Street was the company’s forecast, offered a forecast for gross margin this quarter to drop to 36% from last quarter’s 40%, and warned that its new chips coming out in video game consoles from Microsoft (MSFT) and Sony (SNE), which have been a big reason for optimism about the company, will carry gross profit margin “in the low double digits” on a percentage basis, which is not what many on the Street had been hoping for.

When Merrill Lynch‘s Vivek Arya asked on the call whether that low margin would persist, chief financial officer Davinder Kumar was unable to say yes or no definitively:

I think — we’re giving guidance for Q3 and guiding to the low single digits from a Q3 standpoint. As you can imagine, this business, the semi-custom business and game console, in particular, has a long life line. And over time, the mix between the ASPs and the costs can change. So looking out in the future, it’s hard to tell, but at least at the starting point for the next couple of quarters are pegged at low double digit.

Noted bull Dan Niles of Alpha One was on CNBC shortly after the report yesterday, defending his belief the console cycle will be a big boon to the beaten-down stock. He repeated his view the console systems may add 40 cents per share to earnings as AMD’s chips reach their “full ramp” for the machines; and he still believes the stock can double in two years’ time.

There was debate today about those margins, and about how much is already priced into the stock.

Bulls seem to believe that margins on gaming chips will improve over time, and that the actual dollar value of the new wins with Microsoft and Sony will meaningfully boost earnings, even if the chips are at a lower margin initially. Even some bears seemed to think the implied gross margin for the chips is better than they’d suspected. Both bulls and bears raised price targets.

Bullish!

Hans Mosesmann, Raymond James: Reiterates an Outperform rating on the shares, and a $5 price target. “There appears to be some debate this morning regarding whether AMD’s new console ramp with Microsoft’s Xbox One and Sony’s PlayStation 4 will be either neutral or accretive to overall earnings. While the gross margin profile may have been a little below expectations for the initial ramp in 2H13, our research shows that the next generation of consoles is clearly incremental to overall earnings for AMD. Under the previous generation, AMD had GPU wins in both the Wii and Microsoft’s Xbox 360, with a royalty model generating a few dollars per unit. With the new generation, the Street seems to be missing that the relationship with Sony is entirely incremental, while the Xbox contribution is higher (CPU and GPU vs. just the GPU in the prior generation) and the Nintendo relationship remains the same. Moreover, average selling prices (ASPs) for the new semicustom APU shipments for the new Xbox and PlayStation are in the $60-100 range with operating margins in the low double digits. Thus, the operating profit dollar contribution under the new model is clearly higher.”

Bobby Burleson, Canaccord Genuity: Reiterates a Buy rating, and raises his price target to $6 from $5. “We believe this turnaround story appears to have legs [...] AMD guided Q3 revenue to be up 22%, plus or minus 3% (midpoint of $1.42 billion) compared to our estimate of $1.29 billion and consensus estimate of $1.22 billion. Management guided gross margins to decline to the 36% level in Q3 with increasing mix of semi-custom gaming console chip sales. Operating expenses for the quarter are expected to be $450 million. Management expects inventory to increase to $800 million driven by gaming console semi-custom builds. AMD expects 2013 capital expenditure to be $150
million and expects taxes of $4 million per quarter.”

Bearish!

Stacy Rasgon, Bernstein Research: Reiterates a Market Perform rating but raises his price target to $4 from $2. “While consoles appear to be adding materially to revenues, profitability was an unpleasant surprise, with expectations for “low double digit” operating margins. Given relatively little incremental opex, this suggests gross margins (at least for the moment) far below corporate average, materially limiting potential upside from this business [...] we have been very leery to take the bait1, particularly given the company has been hesitant to provide longer term margin guidance. And, last night we discovered that our hesitance to bite was in fact, warranted. Operating margins for the business were indicated in the “low double digits,” likely materially below investor expectations. A bit of mix analysis suggests gross margins for the initial console business somewhere in the ballpark of 20% next quarter. While we would be surprised to see margins stay here forever (presumably cost position should improve later in the ramp) we believe upside from the business is likely to be materially lower than some of the more bullish forecasts likely behind the stock’s recent run.”

Betsy Van Hees, Wedbush Securities: Reiterates a Neutral rating and raises her price target to $4.50 from $4. “We were impressed with the beat and raise, but believe much of the gaming console design wins are already priced in given the weakness in afterhours trading and 90+% gain YTD vs. 25+% of the SOX. We believe for meaningful appreciation in the stock from this level that we will need to see sell thru of game consoles, continued momentum in servers and notebooks, and traction in ultrathins, and tablets.”

Ross Seymore, Deutsche Bank: Reiterates a Hold rating, and a $4 price target. “The co also delivered strong 3Q rev guidance (+22% q/q) as its APU wins within upcoming game consoles begin to ramp. Unfortunately, this revenue goodness is offset by much lowerthan-expected GMs. Consequently, our recently increased rev ests are rising a bit further, but our EPS ests fall (albeit still above original est). Overall, we applaud AMD’s 2Q execution and believe its gaming wins can stabilize cash flows, but we remain concerned that structural challenges in Computing are likely to re-emerge in 2H13/2014.”

Stephen Chin, UBS: Reiterates a Neutral rating, and a $4.50 price target. “We believe AMD has executed well on its transformation plan as it guided 3Q13 opex down -6% q/q to its stated goal of $450M while guiding 3Q13 up +22% q/q to profitability. We believe further P/E multiple expansion is possible if AMD can execute on its target of operating profitability and positive free cash flow in 2H13 [...] AMD guided 3Q13 gross margin to 36% which suggests its game console (GC) gross margin is around 25% (higher than our initial 20% estimate). AMD expects GC operating margins to be in the “low-teens” which is also higher than our prior estimate of 5%. Since AMD’s GC royalties from Microsoft and Nintendo (estimate $150M/year) will wind down as its GC APU chip sales ramp, we estimate its GC chip sales need to reach $1B in 2014 to improve graphics segment profitability.”

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There are 2 comments

JULY 20, 2013 11:40 P.M.

mr_z wrote:

So with economies of scale and improvements in process technology, we can expect cost of chip manufacturing to go down. This is good for AMD.
But what we don't know is what price discounts, over time, were negotiated with AMDs customers, if any.
If this is so, then margin improvements may not happen.
This could be the reason for hesitancy from Davinder Kumar.

JULY 22, 2013 5:00 P.M.

Mr Green wrote:

AMD took 20% margin on the game box market. Intel took 60% margin and got none of the business. Now AMD is going head to head with Hewlett Packard in the cloud server market. Ask yourself who will get that business.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.